Market Memory

“Memory is a process, albeit a faulty one.”

-Jane Leavy

That quote comes from the Preface of Jane Leavy’s recent Bestseller “The Last Boy – Mickey Mantle and The End of America’s Childhood.” I just started reading it last night and it helped me reconcile some of the conflicting thoughts in my head.

If you open your mind, you can always learn something from someone. Even if that’s learning what not to do. Mr. Macro Market teaches us something each and every market day. Yesterday it taught me that career risk management is as relevant as risk management itself.

At 2:45PM yesterday, the SP500 was testing the 1101 level, making a credible threat to move into what we call the crash zone (down -20% from its YTD peak of 1364 on April 29, 2011). Seventy five minutes later, the SP500 closed the day at 1172 – up 6.4% in 75 minutes of trading! La Bernank calls this le “price stability.”

That wasn’t a bounce. That wasn’t an intraday rally. That was career risk management buttons being pushed (BUY), in size, at the 1100 line – at the intraday and YTD low. Remember, the art of money management is having money to manage.

Market bottoms are processes, not points. And the entire construct of American finance (a large construct) is finally engaging, emotionally, in the process of jogging their 2008 Market Memory.

Many a perma-bull would have you believe yesterday’s intraday rally was based on the “yield differential between stocks and bonds.” Others continue to tell you that stocks went up because they are “cheap.” Right.

To borrow a much more reasonable explanation of what the market does and when, here’s Jane Leavy’s (using America’s treasured pastime as a metaphor for how Americans remember things they are supposed to love): “…like the sweater in my office, Mickey Mantle is a blend of memory and distortion, fact and fiction, repetition and exaggeration.”

Back to this morning’s Global Macro Grind…

As levered long hedge funds deal with their 2011 performance problems in America (they’re down more than mutual funds who don’t use leverage), the rest of the world, shockingly, didn’t cease to exist yesterday.

Across countries, currencies, and commodities, there’s a lot going on this morning:

Singapore’s stock market sold off on that “news” closing down a full -1.9% overnight and really put a large wet Kleenex on what the buy-and-hope crowd in America was looking for this morning - a follow through on yesterday’s bull charge, with a big overnight session in Asia, and big UP futures to story-tell about. Didn’t happen.

2. EUROPE – Evidently, arresting a US stock market crash into yesterday’s close didn’t stop gravity. Economic growth in Europe continues to slow and that’s why German stocks have crashed alongside all of the Europig nations. In bear markets (all of European Equities are in one, fyi), I learn a lot more from the complexion of the bounces than I do the selloffs.

Anyone with a calculator knows that Greece, Italy, and Spain have crashed. But do people realize that German stocks are crashing? Inclusive of this morning’s low-volume +1.6% “bounce” in Germany’s DAX Index, the market is still down -20% from its May 2011 peak. That’s a problem. Germany’s TAIL is broken.

3.USA – Our cerebral Director of Research, Daryl Jones, wrote an outstanding note yesterday titled “Is There Cheap Valuation Blood In The Water” (if you’d like the note email ) and without recapping the entire historical data series, here’s the bottom line on US stocks: they aren’t expensive anymore; they aren’t cheap either – they are perfectly priced for storytelling.

For the sake of a bear’s storytelling purposes, let’s assume the duration of the countless marketing machines out there who are still pitching Jeremy Siegel’s “Stocks For The Long Run” – and let’s use the longest of long-runs. At a closing price of 1172, the SP500 continues to make LOWER long-term LOWS, down -25.1% versus their long-term peak (2007) and down -14.0% from their LOWER-HIGHS established in April of 2011.

Now if we want to throw away our Market Memory for another second and assume the Keynesian Textbook position that ‘low bond yields means buy stocks’, we humbly submit that you still need to get the timing right.

With 2-year US Treasury Yields hitting all-time lows today at 0.17% (all-time is still a very long time) and 10-year yields collapsing toward their all-time lows established in 2008, again, we humbly submit that buying a stock because “it’s cheap” in 2008 should inspire bad memories about what’s left of your 401k. Fictionally “cheap” can get cheaper and repeating the same mistakes gets people run over.

My immediate-term ranges of support and resistance for Gold (bullish), Oil (bearish), and the SP500 (bearish) are now $1, $78.58-89.97, and 1114-1231, respectively. Our Global Macro team will host a conference call at 11AM EST to go through what to do next.

Best of luck out there today,

KM

Keith R. McCullough Chief Executive Officer

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08/10/11 07:36 AM EDT

THE HEDGEYE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP - August 10, 2011

USA stocks aren’t expensive; they aren’t cheap - they are perfectly priced for storytelling. We are hosting a conference call at 11AM today key topics we will be addressing:

Does the S&P500 off over 15% from its YTD highs present a short covering opportunity?

Given our outlook for the global economy, what are the key drivers over the intermediate term?

Sovereign debt issues and the likelihood of resolution, both in the United States and Europe.

As we look at today’s set up for the S&P 500, the range is 117 points or -4.99% downside to 1114 and 4.99% upside to 1231.

SECTOR AND GLOBAL PERFORMANCE

EQUITY SENTIMENT:

ADVANCE/DECLINE LINE: +2651 (+5719)

VOLUME: NYSE 2409.64 (-5.28%)

VIX: 35.06 -26.96% YTD PERFORMANCE: +97.52%

SPX PUT/CALL RATIO: 2.64 from 2.04 (+28.96%)

CREDIT/ECONOMIC MARKET LOOK:

TREASURY YIELDS – obviously some big league career risk management buttons were pushed (BUY) at S&P500’s 1,100 intraday test yesterday (a sub 1,100 move puts S&P500 in crash mode), and immediately after the rally you had everyone and their brother say “because Bernanke wants you to chase yield.” The 10yr yields heading toward 2008 all-time lows are NOT a bullish economic signal!

TED SPREAD: 25.30

3-MONTH T-BILL YIELD: 0.03% -0.02%

10-Year: 2.20 from 2.40

YIELD CURVE: 2.01 from 2.13

MACRO DATA POINTS:

7 a.m.: MBA Mortgage Applications, prior 7.1%

10 a.m.: JOLTs Job openings, prior 2974

10 a.m.: Wholesale Inventories, est. 1.0%, prior 1.8%

10:30 a.m.: DoE inventories

1 p.m.: U.S. to sell $24b 10-yr notes

2 p.m.: Monthly budget statement, est. (-$135b, prior $165b)

WHAT TO WATCH:

BofA CEO speaks on conference call hosted by Fairholme Capital. Moynihan said yesterday he has no plans to step down.

China’s stocks rebounded from a more than one-year low on speculation the government may delay interest-rate increases

Goldman sued by U.S. over credit-union losses: WSJ

FCC to tie review of AT&T bids for T-Mobile, Qualcomm assets

Walgreen to sell health insurance: CNN

COMMODITY/GROWTH EXPECTATION

COMMODITIES – not crashing on the 19 component CRB Index, yet (CRB down -15% since May). But this one is in motion. Oil has crashed and that’s not an inconsequential global demand signal. As a reminder, both Copper and Oil have snapped my TAIL lines of $92 and 4.10, respectively. When my TAILs snap; tail risk becomes probable.

RRGB: UPSIDE SURPRISE

Red Robin is setting up to beat consensus on the top and bottom line in our model.

Red Robin appointed a new Chief Executive Officer in Steve Carley in late 2010 and, since his arrival, we have become incrementally move constructive on the name. Management recently unveiled a new strategy, called Project RED, which focuses on Revenue Growth, Expense Management and Deployment of Capital. While revenue growth is a constant goal of all restaurant teams and a sound bite in every earnings call, the extent of the expense cuts management is proposing is impressive. Below I discuss the revenue and expenses outlook in more detail.

REVENUE

Same-restaurant sales are trending more positively over the last few quarters and, we believe, the company’s Project RED will enable it to take share going forward. Our estimate for same-restaurant sales is 2% for the second quarter. This implies an acceleration in two-year average trends of 60 basis points from the first quarter.

The company’s growth profile is also attractive from an investment standpoint. New unit growth is accelerating by 25% to 10 new openings in 2011 and average weekly sales for the non-comparable store base continually exceeds those of the comparable store base. The company opened only two stores in the first half of 2011.

During the last earnings call, management highlighted the new loyalty program, Red Loyalty, as a key component of the top-line strategy going forward. The loyalty card program not only allows the company to retain customers but also enables management to learn more about the customer base and target future sales strategies more effectively.

The company took a 1.5% price increase in April which will help margins as beef costs remain elevated.

EXPENSES

Management is targeting 200 different cost savings through the end of 2012 which, it is hoped, will yield $16-18 million in annualized cost savings. We find the meticulous manner in which management is pursuing savings, big and small, to be encouraging given our preference for expense-cutting (EAT) turnarounds rather than spending to turn around a company (PFCB). Everything from lowering food waste to renegotiating trash contracts is being focused on.

Commodity costs remain a concern for the company given its exposure to beef. In May management said, “Ground beef could be higher by as much as 20% year-over-year, which has a meaningful negative impact to our margins”. Looking at the price of beef since that earnings call on May 19th, it is up 4% but prices have been volatile as weather impacts, changing global consumption patterns and slower economic growth impact commodity prices. Commodity guidance given in May was for 5-6% inflation over the remainder of the year and we believe that it’s unlikely any downside revision will be made to that range.

In terms of expectations going forward, management is guiding to 80-100 basis points of margin expansion due to labor efficiencies.

As the quadrant chart below illustrates, RRGB’s operating performance has improved markedly over the past couple of quarters and, given easy compares for the next few quarters and the company’s focus on costs savings, we expect the next quarter to be strong.

SENTIMENT

Sentiment has improved in this name and estimates have risen but we still think that the 2Q11 consensus EPS number of $0.36 is $0.05 or $0.06 too low. Given that 17% of ratings on the stock are “Sell”, there could be still additional sentiment shifts to the positive side coming soon.

Short interest, at 15.7%, is a bullish data point in that any upside surprise in EPS could prompt short covering and a nice pop in the stock price. With the Knapp Track casual dining sales index having trended positively through the quarter and the company doing all it can to target controllable costs, we see a strong quarter from RRGB as a distinct possibility.

Howard Penney

Managing Director

Rory Green

Analyst

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